For RMF, one of U.K.-based Man Investments' core investment managers, ramping up a second collateralized debt obligation was a piece of cake.
"We started ramping RMF Euro CDO II up at the beginning of February, began marketing it at the start of March and we'll close on June 24," said Peter Cannon, senior portfolio manager, who manages RMF's first CDO (RMF CDO I), and will manage its second one, too.
To be sure, this is the season for CDOs - particularly loan-backed vehicles - in both the U.S. and Europe. New structures from both established managers and newcomers to the CDO business are filling the pipeline. RMF is one of the more established managers, having launched its first CDO, RMF CDO I in October 2001. Consequently, RMF had no trouble drawing investors into its new venture.
"RMF CDO I was harder to get off the ground because we were a first time manager without a CDO track record, and because we were in a tough market post [Sept. 11]," Cannon said. "Now, we have proven ourselves to investors - we have shown that we have a lot of experience with credit, that we invest well and avoid losses, so the marketing for the new structure went very well."
Add to all this RMF's strict focus on credit quality, which is key to the investment strategy guiding the CDOs. Cannon and the RMF credit analysts perform stringent analysis on potential assets for their vehicles, taking into account a range of factors they deem important to a company's overall strength and ability to meet its debt obligations as well as the underlying value of the business. Their aim is to strike the optimal balance between individual companies, industry sectors and geographical diversity. "I think one of our many differentiating factors is the extent of portfolio managers' involvement in an individual credit," Cannon said. "I spend much of my time visiting investments, both before and after investing, wherever they are located. That way I am always close to the names in my portfolio, and I strongly believe that makes for greatly enhanced decision making."
Cannon also invests at the higher end of the leveraged credit spectrum - he will rarely go lower than a single-B-minus rated credit for the 300 million RMF CDO II, he said, and this will keep the vehicle in good shape in the event of any corporate downturn.
Of course, RMF CDO II does have a basket dedicated to triple-C credits, but its purpose is more that of a "safety net," Cannon said, one that he prefers to keep as unencumbered as possible so that any higher rated credits that might get downgraded have "a place to go, rather than create a forced sale."
About 80% of the assets in RMF CDO II are leveraged loans; the remaining 20% of the vehicle consists of mezzanine loans and high yield bonds. Loans offer better recovery value than bonds - they are less volatile and, in general, loan-backed vehicles have done better than their bond counterparts, Cannon said. But having a small segment of the CDO dedicated solely to bonds will enable Cannon to pick and choose from among the "better" issues in the European high yield bond universe, and realize true value from them.
Cannon's overall approach, whether for loans, mezzanine, or bonds, is to buy a large number of small assets. "Bite-size" morsels of between 4 million to 5 million are easier to buy and easier to sell and allow for diversity in the CDO.
"It is easier to sell a bite-size piece of a loan, and I would rather have more assets in smaller sizes," he said.
But how easy is it going to be to find assets, given that this year both the loan market and high yield bond market have been hot, and demand for paper from both regular funds and CDOs has been strong? In the U.S., particularly, managers have been hard-pressed to get their hands on paper, and this has resulted in tighter spreads and managers reaching far and wide for assets, some of which are of questionable credit quality and could have repercussions for the health of CDOs in the longer-term.
In Europe, too, the demand for both high yield loan and bond issues has been robust, Cannon said. However, "the availability of assets in Europe and the spreads have held up virtually without any attrition, and there is a better balance between supply and demand," he said. "We have been able to source assets better there than in the U.S."
As an established CDO manager, launching the new vehicle at this time made perfect sense - not least because the European market is open to the idea of new CDOs, Cannon said. But RMF also waited a significant amount of time before launching its second CDO because it wanted to make sure the first structure was fully invested.
"We wanted to be 100% invested with RMF CDO I in order to show investors that it was a performing fund without any problems," Cannon said. "We wanted investors to see that we delivered what we promised and only then did we choose to focus on our second CDO."
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